kdakota630 (29.55)

Today's Daily Reckoning - Oct.30

8

The big news yesterday: the Fed cut rates to 1%. Only 100 basis points left to go, in other words.

Yes, dear reader, the Fed’s key lending rate will probably go all the way down to zero. And the Dow will probably go to 5,000.

Sooner or later, the dollar will collapse too. We saw a hint of it yesterday...when the buck dropped back to $1.29 per euro.

This morning, Asian stocks are “soaring” on the news of the Fed cut. Predictably, investors think the feds finally might have this thing under control. Predictably, they are wrong.

You’ll recall that the credit crisis began in the summer of ’07. Before that the ‘war’ between inflation and deflation had been an even match. But then, sub-prime debt came upon the battlefield like a new tank. In a matter of days, deflation seized the high ground and has been winning ever since.

Of course, you have to give the feds credit. They’ve fought a good fight. First, in England, they bailed out Northern Rock and later nationalized the whole banking system, guaranteeing practically all deposits. In the United States, they abandoned Bear Stearns to the enemy, but they took over Fannie and Freddie...and rescued AIG, when Hank Paulson realized that his firm, Goldman, had $20 billion at risk. Then, they handed out over $100 billion in “tax rebate” checks. When that didn’t seem to do the job, they passed a $700 billion bailout bill – in which Paulson will buy up his old crony’s mistakes. And now they are talking about another general rescue effort at a cost of a few hundred billion more.

The Fed, meanwhile, has been doing its part to support the war against free markets. They’ve cut rates, of course. They’ve also traded their good credits for Wall Street’s bad ones. That is, the Fed’s balance sheet used to show billions in U.S. Treasury bonds...and little else. Now, the Federal Reserve has one of largest stockpiles of financial roadkill in the world...and only 100 basis points of ammunition left!

None of the measures taken so far seems to have done the trick. The cutbacks continue...in fact, they are just beginning.

“No more travel,” said one corporate directive we saw yesterday.

“Cut out all training,” said another. “We’re not hiring anyone new and if the others don’t know their jobs by now, get rid of them.”

“Stop printing things...just send them out by Internet,” was yet another cost cutting measure.

And soon, the printing presses will be silent...the pulp mills will slow down...and there will be shorter lines at airports security checks...

...and all these things...along with millions of others...will mean fewer jobs.

The news this morning tells us that the economy is still sinking. The latest figures show US GDP falling at a 0.5% rate. New York’s governor said the slump will mean 45,000 layoffs on Wall Street – worse, he said, than the Great Depression. Gov. Paterson went on to say the state faces a deficit of more than $40 billion over the next 18 months.

In September, 159,000 layoffs were recorded. And now the LA Times predicts that even Hollywood will have to layoff workers.

Mortgage applications are still in decline. Housing prices are still falling. And the Wall Street Journal reports that not even drugs are selling.

Yes, dear reader, the people who caused the financial crisis – the feds – are now going to make the situation worse. Instead of letting the chips fall, they will prop them up as best they can...fighting the deflationary correction process every step of the way. The result will be a slump longer and harder than it should be...most likely becoming the First World Depression, FWD.

There were only two instances of major credit contractions in the 20th century. In each case, government intervened to stop the process of correction. And in each case – first in the United States after the crash of ’29...then in Japan after the crash of ’89 – the feds used every weapon in their arsenal to try to prevent deflation. And both times they only managed to deepen the pain...and stretch out the recovery over more than a decade.

Pity the poor investors in Japan! At the beginning of 2008, they had been waiting 18 years for a recovery. Instead, they got another 50% cut in the value of their stocks.

After the bailout of Wall Street, everybody wants cash. The automakers are at the head of the line. Auto sales fell 6% worldwide in the 3rd quarter. GM says its North American sales were worse – off 18.9% from last year. If it doesn’t get some money from the government, it will go broke.

Yesterday, the governors said were going broke too. Unlike the feds, the states cannot print money on demand. They have to go to the U.S. government for a handout.

The banks, Wall Street, mortgage lenders, the states, the automakers...by controlling the cash, the feds can control everything. Until the cash gives out, of course.

Here, we think we see another ‘trade of the decade’ coming up. Dan Denning offers this insight:

“The 30-year Treasury bond yield plunged 27 basis points last week to 4.062 percent. It reached 3.8676 percent on Oct. 24, the lowest since regular issuance of the security began in 1977.

“This is the last big bubble. There’s going to be a stiff penalty for staying in Treasuries as the supply increases (the three-year note is coming back, monthly auctions for ten-year notes will resume). Plus, you know, all that new stimulus. All that new borrowing.

“Yields will be going up for sure...

“I think the big takeaway is that equities – certain ones mind you – make much better inflation hedges than bonds, especially U.S. government bonds. If you don’t want to own best-of-brand businesses now at these prices (including resource and energy companies) then would you ever want to own them? If you’re going to be in the equity markets at all, you could probably make a list of just five or ten companies to own for the next ten years, buy them now, then throw away the key.

“This is actually advice I gave to my family. I said, ‘Look, being in cash is safe now. But it’s going to be a liability. You have a little time before everyone comes out of their caves and begins buying again. The panic that swept the markets has abated. Obama is Messiah. It’s all good. This looks like the 1929-1930 50% rally. But more importantly, cash will get trashed in an inflation...and believe me...it’s coming. Big stimulus (Roubini says $400 billion plan). Democratic veto proof majority in Congress. Stocks will be better than bonds or cash (as Buffett said in the NY Times). But which stocks? You could buy as few as five – and you might not ever need to buy stocks again (you might never want to either). But if all you do is buy these five now – you probably won’t regret it in five or ten years. And if it IS the Great Depression...well then...you’ll have other things to worry about anyway...like a roof over your head...or your empty belly...or how to avoid that gassy smell coming from Uncle Rufus.’”

There’s a good chance it will come to that, says Ken Rogoff, former chief economist at the International Monetary Fund.

“They're going to cut more. They're not done. I think we're going to end up down at zero,” Rogoff told public radio program Marketplace.

“But they don't really want to get there, because they don't know what they'll do next. After it's at zero.”

Things are that bad, says Rogoff. So bad that the rate cut isn’t really comparable to the similar moves made by former Fed Chairman Alan Greenspan a few years back.

“We're facing the financial mess of the century. We've been in it deep for more than a year. We're in a recession. There's really no credit flowing in the economy. Unemployment's rising. There's a global recession going on,” Rogoff said.

“So, it's really quite appropriate to cut rates here. In fact, we see credit still very tight despite the Fed having such low interest rates.”

At least one former Fed governor sees zero ahead as well.

“Zero is a possibility,” former Fed Governor Lyle Gramley, now an adviser at Stanford Group Co.

I was a subscriber to The Daily Reckoning for a few years in the 1990s. They have basically called for this derivative-based demise since that time. They were indeed prescient but like most of us they were lousy timers of the market. I stopped reading them in 1998 because too much gloom-and-doom reading costs you money because you fear the eventual downturn (always a downturn is coming in every market) and become afraid to pull the trigger on stocks.

I am taking their advice now though and buying 4-5 stocks soon (mostly because that is all of the cash I have). They will be cash-rich with little debt; industry leaders in particular industries only; significantly off their highs and dividend-paying (I want some kind of return if I am waiting a long time for the sun to shine again).

The industries I have chosen (1 stock each) are aerospace-defense because Biden has already warned us that Obama will be tested within 6 months and even if McCain were to pull off a miracle Nov 4 there is just too much unrest in the geo-political world. I have a nagging suspicion that no matter what happens in this election something major is on the horizon.

The second industry I have chosen is energy because I do not believe the rapid drop makes any more sense than the meteoric rise through the first part of the year. Yes we will curtail driving during a recession. We have done it in the past in the early 1980s and we nearly bankrupted the free-spending sheiks of the middle east but the global times have changed. Energy is needed everywhere and the third-world is getting smaller not larger.

The third industry is the agriculture/fertilizer companies who have been absolutely pounded because of the weakness in fertilizer prices and a fear of a first-to-third-world depression like in the 1930s. I just cannot fathom agriculture declining for very long. If everything else goes to hell people still have to eat and there isn't enough quality arable land to feed all of them without the help of the nutrients that these firms supply.

The fourth industry may be metals as they have fallen deeply also or it may be industrial manufacturing. I haven't really decided yet.

What there will not be is any banks or financial stocks, yet. We are not out of this crisis yet. I do not think I want any retail because I think people are going to stick to the essentials for awhile. Panic selling = little buying. That doesn't mean all retail is bad. People need the basics. If Walmart were cheaper I'd probably load up on it. I am looking at Walgreen because it is an industry leader but then again so is Home Depot and we know that story.

Bill Bonner and all of the staff at that investment paper are brilliant. I have been hearing about the danger of derivatives for 15 years from other sources as well (has anyone out there ever heard of Nick Guarino?). Mortgage-backed securities and other derivatives are older than that, of course, but the trading always made a modicum of sense because it was a good way for hedging asset and commodity prices. The financial centers lost their brains beginning in 2003 though and coupled with government pressure placed on urban mortgage firms through the CRA (Community Reinvestment Act) giving mortgages to anyone regardless of ability to pay we are now having to clean up a huge mess. Look at DWOTs blog and check the Alt-A mortgages that are coming due over the next 8 years. It will take a long time to clean this mess up.

At any rate it is good to see The Daily Reckoning advising a long-term buy scenario in certain equities. The investing lessons I have learned from them have rewarded me handsomely over the years.